Definition of Acid Test Ratio
The acid test ratio, which is also known as the quick ratio, compares the total of a company’s cash, temporary marketable securities, and accounts receivable to the total amount of the company’s current liabilities.
The acid test ratio is considered to be a better indicator of a company’s ability to meet its current obligations than the current ratio because inventories and prepaid expenses are not included.
Example of Acid Test Ratio
Let’s illustrate the acid test ratio by assuming that a company has cash of $7,000 + temporary marketable securities of $20,000 + accounts receivables of $93,000. This adds up to $120,000 of quick assets. If the company’s current liabilities amount to $100,000 the acid test ratio is 1.2:1.
A large acid test ratio gives creditors confidence that the company will be able to meet its current obligations when they come due.
